Thursday, October 18, 2012

Best Buy (BBY) - Option Market Reflects Potential of Takeover Pre-Earnings; But Downside is Not Backwards

BBY is trading $17.45, down 0.8% with IV30™ up 1.5%. The LIVEVOL® Pro Summary is below.


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Best Buy Co., Inc. is a multinational retailer of consumer electronics, computing and mobile phone products, entertainment products, appliances and related services.

This is a vol note -- specifically skew as earnings approach. Having said that, any note on BBY has to include at least an allusion to the goings on of a potential takeover / private by the ex-Chairman.

Here a list of headlines that I copied from a blog I posted on 8-29-2012 as well as a link to the article iself.

Best Buy Co. (BBY) - Options Reflect Upside Potential in Near-term; Vol Diff Gaps Open to Upside

06-Jul-12 15:23 ET: Best Buy to layoff 2400 employees - CNBC

11-Jul-12 09:33 ET: HHGregg at a 3.5 year low following Q1 warning and FY13 guidance cut, now off ~32% (7.80 -3.74) -Update BBY -6%

13-Jul-12 09:42 ET: Best Buy trading lower off the open; Hearing cautious comments at Cleveland Research

30-Jul-12 08:44 ET: Best Buy spikes to $20 then comes back to ~$19 following renewed takeover reports;

30-Jul-12 08:43 ET: Best Buy founder Schulze recruiting executive team for buyout - Bloomberg

06-Aug-12 08:35 ET: Best Buy Founder Richard Schulze confirms proposal to acquire BBY for $24.00 to $26.00 per share

Provided by (

Clearly there's been more news -- all we need is the equity market price to see that -- $17.50 is not $24-$26 (takeover price rumor).

But, I want to focus on the Skew, so let's start there.  The Skew tab from today is included below.

As far as I can tell, the next earnings release for BBY should be in late Nov, but likely after Nov expiry. What we can see in the skew is an abrupt upside vol in the OTM calls when compared to the other strikes in Nov and certainly the other strikes in Dec. I've highlighted the vol diff that has opened to the upside.

The skew hasn't always looked like this. In fact, we can see the Skew Tab from 10-3-2012, below -- and how this weird shape discrepancy was not apparent.

The Dec options (green curve) laid above the Nov options (yellow curve) across all strikes -- a reflection of the risk in earnings. It's the news over the last fifteen calendar days that has created this rather dramatic shift. Here are the headlines since 10-3-2012:

10-3-2012: According to reports Best Buy (BBY) founder Richard Schulze and four private equity firms are preparing a possible $11 bln buyout of BBY.

10-9-2012: Best Buy announces it is conduction a search for a new CFO

10-10-2012: Best Buy founder Richard Schulze has made progress toward making a bid for BBY, according to reports

10-12-2012: Best Buy is planning on matching online competitor (AMZN) prices this holiday season, according to the WSJ

10-16-2012: Best Buy: Reuters reporting BBY is planning to price its own Android tablet 'insignia flex' at $239 to $259

Source: (

So new technology, a competitive move against AMZN and more of the takeover "stuff" -- all in a relatively short period of time.  The result is... that shift in skew.

Let's skip the Charts Tab this time, and just go straight to the Options Tab.

We can see the vols across the top, specifically that Dec is priced to 62.84%, while Nov is priced to 58.81%. So, it does seem that the option market reflects that the vol event (earnings) is due out in Dec (and not Nov).

But, looking at specific strikes, checkout the Nov/Dec 20 call spread (as one example) -- where owning the earnings month costs ~63% vol while selling to pay for it with Nov sells ~68% vol. There are several of these spreads as well as diagonals to the upside, where owning Dec (and earnings) is less expensive (in terms of vol) than owning Nov.

Of course, the takeover news (or possibility of it) is a non-trivial risk factor which the option market reflects quite clearly. It is interesting to note that the case is not reflected in the downside options (OTM puts), if we look back to the Skew Tab from today. In English, the options reflect greater upside risk (potential) in Nov vs Dec (and earnings) but not to the downside. Hmmm....

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